Stock Market Shangri-La

The big news early in the week was that Larry Summers – the man so smart he lost hot breakfasts for Harvard and $2 billion of the university’s operating funds – withdrew his name from consideration for the next Federal Reserve Chairman. The stock market loved the news. The S&P 500 jumped a combined 13 points on Monday and Tuesday.

By Wednesday the relief of not having Summers tinkering around with monetary policy had been cast aside. All eyes were recalibrated on current Federal Reserve Chairman Ben Bernanke, and his forthcoming utterances. What would he do now?

Many were expecting the Fed to begin tapering back its $85 billion per month asset buying program by about $10 – $15 billion per month. But when it came time for the monetary Caesar to taper he did nothing of the sort. Here are some choice excerpts from Wednesday’s FOMC statement…

“Taking into account the extent of federal fiscal retrenchment, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month.

“The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability.”

Stocks Up, Dollar Down

Here we’ll pause for a brief moment to appreciate where the Fed gets $40 billion per month to buy mortgages and $45 billion per month to by Treasuries. If you recall, the Fed just creates the money through a simple ledger notation…and presto, it has money to loan to the government and the big banks at interest. The Fed then chalks these loans up as assets on their books.

To clarify, tapering doesn’t mean the Fed would stop creating money from nothing outright; it just means they’d cut back a little. Yet at this point Bernanke’s scared to even taper back a bit. For the economy’s grown so dependent on ever more issuances of debt based money that he can’t stop.

Obviously, these are not the monetary policies of a recovering economy. They are the policies of an ailing economy. Regardless, the stock market loved the news.

During Bernanke’s press conference the DOW jumped 178 points to an all-time high of 15,708 and the S&P 500 ran up to 1,728, also an all-time high. Gold spiked up too. But one thing didn’t go up – the dollar. It went down…falling to a seven-month low.

Moreover, what does this heavy handed intervention into financial markets give us? It certainly hasn’t resulted in a booming economy.

Stock Market Shangri-La

Government spending – be it from debt or taxes – doesn’t produce new wealth. Unquestionably, it’s proven to be a failing model for growing an economy over the last five years. The labor force participation rate is now at the lowest level since 1978 – back before women entered the workforce in earnest.

The Fed’s quantitative easing policies haven’t done a lick for the average Joe either. From what we remember, when these crude policies were put into place the monetary masters said all the cheap credit and funny money would stimulate demand for goods and services, which would create an abundance of new jobs. It has done nothing of the like.

But it has succeeded in recapitalizing bank balance sheets. You know how that works: The banks borrow money from the Fed for practically free and then lend to the Treasury for a 2 percent spread, or thereabout. Even someone with an MBA – and a belief in graphs – could figure out how to make a buck with that setup.

The Fed’s also succeeded at inflating the stock market. The cheap money’s flowed into stocks like cheap beer into a frat boy’s gut on spring break in Ensenada. Of course, after this goes on for a while something bad is bound to happen.

When the price of money – the interest rate – really rises, and the flow of money reverses, the current stock market Shangri-La will be shown to be a mirage. In the meantime, Bernanke wants to delay the inevitable for three more months so he can exit the Fed and someone else can clean up his mess.